Global commodities in a post-Ukraine-war world
Irreconcilable differences: what happens if Russia’s ties to the West are severed?
The war in Ukraine is transforming energy and commodity markets. Oil prices are constantly above US$100/bbl and diesel has been at record premiums to crude, while global gas/LNG and coal prices are trading at all-time highs of up to four times their previous 10-year average. Commodity price volatility to-date since Russia’s invasion of Ukraine, however, has been the result of self-imposed sanctioning and fears of supply loss. The imposition of total bans on Russian imports will only amplify this.
Europe’s energy dependency on Russia Energy prices
Source: Wood Mackenzie
For this edition of Horizons, we assume the following developments and bans come into play. We then use our integrated analysis to consider these consequences of the war over the next decade and compare this to our base case Strategic Planning Outlook:
- A ‘war without end’. Low-intensity conflict in Ukraine drags on for years, keeping tensions high between Russia and ‘the west’.
- Europe will ban Russian coal from October 2022. This will be followed by the European Union’s ban on most oil and refined products by the end of the year.
- Banning Russian metals will increase energy transition costs, but Europe is unlikely to allow exceptions. We assume an EU ban by the end of 2023.
- A sudden ban on gas would usher in recession for Europe. But through its REPowerEU plan to accelerate renewables, manage demand and add LNG import infrastructure, the EU could press for an earlier ban; we assume end 2024.
- Asia is split. Japan and South Korea will follow Europe (and the US) and ban Russian commodities. China and India will look to benefit from discounted Russian imports, but pragmatism will rule – both will want to maintain good relations with key export markets.
- GDP growth will slow and, in tandem, global energy demand.
Gas: Europe goes on an LNG spending spree
Despite the challenges, Europe has already dramatically reduced its dependence on Russia gas, as record gas prices trimmed demand and facilitated an unprecedented wave of LNG imports. As a result, the EU is set to import only 90 bcm of Russian pipeline gas in 2022, a stark reduction from the 140 bcm it imported in 2021. A positive scorecard so far, but additional cuts will be harder to achieve over the next few years. High prices have already forced thermostats down, maximised the use of coal and put energy-intensive industries out of business. The EU has pledged to spend hundreds of billions on renewables, low-carbon hydrogen and energy efficiency to reduce demand by another 150 bcm, but little of this will come by the end of 2024. Our Strategic Planning Outlook features a steady reduction in Russian imports in line with existing contracts (some of which extend beyond 2030), and a softening of prices. It has been precisely the risk of Russian supply disruption that has pushed traded prices north of US$30/mmbtu in recent months. Prices will inevitably rise should EU enthusiasm for banning Russian gas become a reality ahead of the next wave of new LNG supply after 2026.
Coal: if you’ve got it, you’ve got it
With an EU ban already announced for October, ARA prices have been trading at historical highs of more than US$350/t, a 300% increase from last year. Since the invasion of Ukraine, European buyers have been steadily negotiating long-term contracts with alternative coal suppliers, reportedly paying above spot prices at times. European coal imports doubled in April as supply was redirected from other markets. Europe’s scramble to acquire long-term contracts has inadvertently shifted more of the shortage ‘pain’ to Asian markets, with local buyers struggling for spot cargos to ensure adequate stockpile levels amid the increasingly short seaborne coal market. Coal prices in the Pacific continue to rise and are now well above ARA, at over US$400/t Newcastle 6,000 Kcal. Higher international prices are pushing China and India to double-down on domestic developments. As top consumers and producers of thermal coal, each has tremendous sway over the global market. They will both seek to reduce exposure to the more volatile import market by increasing cheaper domestic production, which will ease demand pressure on the seaborne market and reduce prices. Our post-war view considers a managed reduction in Russian coal imports in Europe, with prices softening as some Russian coal is absorbed in Asia. However, full implementation of the EU ban, followed by similar action from Japan, would require an increase in alternative supply. Amid environmental, social and governance (ESG) concerns and reduced access to capital, seaborne coal supplies have become less responsive to higher prices – particularly for the high-quality coal segment. As a result, global coal markets will remain tighter for longer, keeping prices higher than our pre-war view in the near term. ARA prices are expected to end the year at around US$250/t and remain well above last year’s levels until after 2024 as the market rebalances.
Source: Wood Mackenzie
Metals: the answers lie in China
Kicking the Russian metals habit will be hard. Russia produces typically 3% to 6% of global metals supply and significantly more of the world’s palladium and high-quality iron-ore pellet feed. Metals prices spiked following Russia’s invasion of Ukraine, with mounting concerns about supply disruptions from sanctions and bans adding fuel to the fire. The knock-on effect of high energy prices on marginal supply costs has kept some metal prices high. Yet despite self-sanctioning, demand for Russian metals remains robust, albeit at more modest price premia. The effectiveness and implications of a future ban on Russian metals hinges on two key questions. First, will non-sanctioning countries absorb Russian supply and refined output? And, if not, can global supply chains function while alternatives are developed without an extended period of shortage? The answers are likely to come from China. The country could readily absorb Russian metals if they were banned in western markets, but Europe and others will want to ensure that ‘washed’ Russian metal – processed and used in manufactured goods by China – doesn’t simply find its way back in. Alternatively, China could secure raw-material feed from Russia for its dominant smelting and refining sector and leave western markets facing supply deficits and higher prices. If, however, Russian metal was shut out of the global system with minimal redirection to alternative markets, this would very quickly lead to even greater deficits and higher prices. Markets would remain tight for several years until new supply was developed.
Global CO2 emissions: Strategic Planning Outlook vs Russian import ban scenario
Source: Wood Mackenzie
These upward pressures on emissions will be offset by the consequences of slower economic growth. Even with coal holding its own in Asia, weaker overall energy demand growth should set the world onto a lower CO2 emissions trajectory. It is scant consolation when emissions can be curbed only by restricting improvements in global prosperity and living standards.
The global economy: pragmatism rules
As discussed in our April Horizons, Russia’s rapid isolation from many of the world’s major economies is hugely disruptive. But Russia will not become a pariah – its ample natural resources preclude this. However, no economy faces a greater challenge when it comes to substituting imports and diverting exports. Asia will be key, but Russia may find avenues closed as some prefer not to swim against the current of much of the global economy. Pragmatism rules: the G7 plus remaining EU accounted for 42% and 38% of China’s and India’s exports, respectively, in 2021. China will put its own interests ahead of its ‘no limits’ friendship with Russia, while India walks the line between courtship by the west and historical ties with Russia. This isn’t the end of globalisation, but it is a structural shift as global trade becomes more regionalised and increasingly defined by politically aligned trading blocs. And while some stand to gain from import substitution, most notably Southeast Asia, Africa and South America, the net economic impact is negative. Wood Mackenzie estimates that a cumulative US$9.3 trillion could be wiped off global GDP by 2030.
Conclusion: Rapid response required
Russia’s war on Ukraine has reshaped the commodities world and catapulted energy security to the top of the global political agenda. Energy trade flows are being transformed, investment in new LNG supply looks more compelling and the pace and cost of the energy transition is changing. Governments, companies and investors must respond. Governments – Countries with domestic hydrocarbon and critical mineral resources will need a twin-track approach: maximising production of their resources in the short term while stepping up investment in low-carbon energy supply to meet future demand in the long term. The huge challenges facing global supply chains can only be resolved by governments supporting strategic investments to overcome bottlenecks. Investors – Investment opportunities are widening. Energy transition investments will be more expensive, but higher commodity and power prices mean they remain competitive. European wind and solar looks a solid bet. Energy security priorities will ensure returns remain attractive for hydrocarbons and, increasingly, critical infrastructure. US LNG looks the most attractive option, capable of being delivered to market quickly and with limited capital exposure. However, the era of mega oil and gas projects is not coming back. Companies – Hydrocarbons will be tremendous money spinners for some time to come. We continue to see attractive opportunities for low-cost, low-carbon supply of oil and gas from the national oil companies (NOCs). But large-scale investment by IOCs in traditional oil and gas projects, as well as international miners in coal projects, will be increasingly displaced by growing investment in low-carbon energy projects. High and volatile prices will require a renewed focus on trading capabilities and fungible assets. Metals could be the next growth areas for cash-rich IOCs.
Source: Wood Mackenzie